Profit Sharing Plans

Cash or Bonus Plans, whereby the employee receives cash at the end of the year and is taxed on the amount at the same time, and

Qualified Deferred Profit Sharing Plans which deposit funds into separate employee accounts to be distributed and taxed at a future date.

Profit Sharing Plans are often used in conjunction with 401(k) plans.

Benefits to The Employer:

The employer is not obligated every year, to contribute a set amount or any amount, as long as the contributions are generally significant and recurring.

The employer can limit which employees are eligible to receive benefits, based on months in service, age, or coverage in a union plan.

The employer can limit how much certain employees may receive based upon rank or salary level.

Investment risks lie completely with the employee.

Contributions are tax deductible by the company, up to 25 percent of covered payroll. (Although an employer is limited to contributing only up to 15 percent of covered payroll, if in a prior year the employer only contributed 5 percent, the employer would be allowed to contribute an additional 10 percent to the current year’s 15 percent).

Vesting allows the employer to reward employees who devote years to the company while penalizing those who terminate early, enabling the employer to retain the most experienced workers.

If an employee leaves before completing a vesting schedule, the employer has the option of using the forfeited funds to reduce future allocations of profit or may divide the amount among the accounts of the remaining employees.

Benefits to the Employees:

All contributions are made by the employer.

Employees do not presently pay taxes on the contributions.

Generally, the employee may have an IRA in addition to the profit sharing plan.

Participants may borrow from the plan if the plan permits.

Allocation of Benefits

Four common plans for allocation of benefits are:

Non-Integrated Plans – All employees’ benefits are in direct proportion to participant compensation. For instance, all employees receive x percent of their compensation.

As you can see Profit Sharing Plans provide great flexibility to employers. These plans are especially popular with companies having few owners or one, employers whose owners or key employees are significantly older than the rest of the workers, or where the objective is to provide the maximum benefits to executives and higher compensated employees while minimizing benefit costs to rank and file workers.